The introduction of pension reform and the so-called Riester pension in 2001 was merely a first step towards overhauling the pension system. The reform was soon followed by disenchantment. High unemployment, for instance, is making it increasingly difficult to fund pensions. However, the greatest single risk lies in demographic trends. For this reason, there is no alternative but to build up funded pension provision.

, Jul 31, 2003

As the population ages the proportion of those in work in the population as a whole will continue to fall sharply; at the same time the proportion of old people, those over 65, will rise drastically. This leads to a deterioration in the so-called dependency ratio, which measures the ratio of the over-65s to the 15-64 year-olds: the figure will climb from around 24 % at present to a good 50 % in 2050. In a pay-as-you-go pension system this will give rise to enormous budgetary problems.

This poses major challenges in many areas for policymakers. And what makes these problems particular and therefore difficult to handle is that they only take effect in the long term. The options in our pay-as-you-go pension system are now limited, it is caught in a vicious circle: if you tackle the problem by raising contributions, the higher levies undermine economic performance and reduce growth. As a result, the sum of earnings available to fund pensions declines, necessitating a further round of measures to safeguard pensions. But confronting expenditure boils down to a direct cut in the pension level.

What path are we on today with our three-pillar system of pension provision following the 2001 reform? Are the measures already taken sufficient? Will the reforms reduce pressure on the statutory pay-as-you-go system?

In our publication we show that central components of further pension reform in Germany need to be an increase in the effective retirement age and a reduction in benefits coupled with the simultaneous bolstering of the funded elements. A higher retirement age has several effects: it increases the number of contribution payers, reduces the number of pensioners and shortens the pension span. A major step would be to bring the effective retirement age, currently at around 61 years, more in line with the statutory retirement age of 65. A further reduction in the pension level beyond what has already been passed is unavoidable given the demographic trend and the pain threshold of contribution payers.

For all these reasons it is therefore urgently necessary to expand funded pension insurance further. The great advantage of a funded pension is that it places retirement provision directly in the hands of the individuals who safeguard their own future with their own savings. This creates incentives to work and save more, boosting overall economic momentum. The likely changes in the level of the state pension will alter behavior patterns among private households. The propensity to save is likely to rise, leading to higher savings in the next 10 to 20 years. Thereafter we expect to see the older generation dipping into their savings, with savings activity declining noticeably. At the macroeconomic level this will have an impact on economic growth and the current account: in the short term growth will be curbed by the increased saving which hits consumption. From 2025 we could see a reversal in the current account: surpluses could turn into deficits. At the micro level, everybody needs to be aware that financial provision in retirement will increasingly be placed in the hands of the individual.